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Tuesday, July 14, 2009

Previously we had analysed companies combining two very basic factors (return and value), which essentially make for good bets over the long term. We had said that even if these stocks move slowly, they are sure to create shareholder value because they earn a high return on capital employed (RoCE) and are available at a reasonable valuation. These companies can handle recessions, credit crunches and deceleration of demand much better than others. What about exactly the opposite kind of companies, ones that earn a low return on capital and are expensive? Welcome to Indian television channels – the playground of ego where the ambition of promoters decimates RoCE but keeps the valuation high, thanks to the stupidity of glamour-struck institutional investors. The liberalisation of television broadcasting in the early 1990s saw a host of players rush to set up satellite channels to service the large and virgin Indian market. This was seen as a glamorous new business, the most obvious way to fund which is to raise money through equity. Accordingly, a large number of promoters have raised money to channel their ambitions. The problem is that there are too many of them. Soon, it becomes a game of one-upmanship leading to oversupply, a situation ripe for poor returns and underperformance of equity. But shouldn’t many of these have gone out of business by now? Unfortunately, glamour businesses, even when they are faltering, have a long life. Poor returns are bolstered by more equity placements from a new set of dumb institutional investors eager to swallow a new storyline: a new round of expansion or even restructuring.More horrifyingly, many channel companies are now backed by debt.Glamour businesses ought to be cash cows when the going is good. Piling up capital leads to a horrendous RoCE (debt plus equity). Of the seven channels on our list, just two are free from long-term debt. Others have accumulated huge debt – proportional to the ego and ambition of their promoters. Where do TV channels go from here after having raised tonnes of money to fund their operations only to fight a bitter battle to grab crumbs of a fragmented market?

TV18 pioneered business news in India. It now owns and operates two channels (CNBC TV18 and CNBC Awaaz) and has interests in the Internet business. Its consolidated operational income was up 61% in FY08 compared with the year-ago period while operating profit was up 24% over the same period. That was great but, despite a smart rise in its operational income, the company’s operating profit growth was not impressive, thanks to rising cost of operations. Some 26% of its income goes into staff costs. It has acquired Infomedia 18 which boosted the topline but does not make money. News is the only profitable business segment but it is extremely cyclical.During the past five quarters, it has consistently reported losses in all its other segments. The business makes low returns. The company earns an operational RoCE of just about 11%. This is obviously because its balance sheet is heavily debt-ridden. It carries a long-term debt of Rs479 crore in Rs680 crore of capital employed. RoCE is a poor 11%. Amazingly, even after the recent price collapse, the enterprise value is 200 times the RoCE.

The story of ibn18 Broadcast, promoted by TV18, is worse. This company operates three news channels: CNN IBN, IBN7 and IBN Lokmat. It has a debt of Rs75 crore in Rs155 crore of capital employed and earns a pathetic 6% operational RoCE. Its consolidated operating loss was about Rs7.04 crore in FY08 on a turnover of Rs131.78 crore. How much did employees take home during that year? Staff costs, including ESOP expenses, were Rs44 crore – as high as 34% of its revenues. That was in a boom year. In the first two quarters of the current year, it has already amassed losses of Rs24 crore on a turnover of Rs60 crore with staff costs rising to 38% of turnover. The December quarter has been an utter disaster. Consolidated loss was Rs21.90 crore. But staff expenses are up, not down. Among our list of channel companies, it had the most anaemic RoCE in FY08. For FY09, it will be negative.

NDTV should qualify as the finest example of a noxious mix that can decimate shareholder value – hype, ambitious expansion and poor returns on capital. While the group continues to announce new ventures to keep up with the competitors, the business is bleeding, possibly to a slow death. This high-profile company has reported an operating loss in all the past five quarters. The group ended the September quarter with a consolidated net loss of Rs119.38 crore against Rs25.27 crore last year. For the December 2008 quarter, the operational loss was a huge Rs103 crore. But employee compensation is flowing thick and fast as before. Staff expenses were 41% of turnover. RoCE was a poor 8% in FY08. The December quarter brought more bad news. Revenues on a stand-alone basis were down 8%; it was alone among the channels, and also among the few companies, to have made an operating loss of Rs6.7 crore. The stock was hammered, with justifiable reason, during the recent crash; there was no bear attack.

TV Today is the smallest and the least ambitious of the lot and has done a better job than its competitors. It has no debt and its RoCE is a healthy 21%. But the business was almost stagnant in the best years. In the December quarter, its operating profit crashed by 43%. RoCE will shrivel in FY09. It also has a high staff cost to turnover ratio.

The two best in terms of returns are Sun TV and Zee. Subhash Chandra of Zee pioneered cable broadcasting in India. But he is also a flamboyant businessman with a variety of other interests (lottery, cricket, fun parks and packaging). All these businesses need capital and Chandra is also suspected to have dabbled in stocks. Of the two listed channel companies, Zee News (ZNL) is doing alright but not Zee Entertainment Enterprises (ZEEL), the flagship, which includes all Zee entertainment channels. Last year, ZNL earned an RoCE of 32% and reported a 53% rise in consolidated revenues in FY08 over the corresponding year-ago period while operating profit shot up from Rs7.71 crore in FY07 to Rs67.77 crore in FY08. While revenue has gone up sharply, a slower increase in its costs has helped improve margins. For the flagship ZEEL, last year was one of the best; consolidated revenue was up 21% in FY08while operating profit shot up 69%. RoCE was 18%. On a shorter term, operating income has managed to rise by an average 36% over the past four quarters while operating profit grew 23% over the same period. Margins are shrinking and averaged 27% over the past four quarters. The December quarter was a disaster. Revenue was stagnant and operating profit crashed by 23%. At least, ZEEL has been paying a dividend averaging 130% over the past five years while ZNL has paid a 40% dividend in 2008. Zee has done better than the others because of controlled costs. Staff cost, as a percentage of revenue, was 10% for ZNL and only 7% for ZEEL. Unfortunately, this is as good as it gets. For Zee to do far better than this calls for sensible business practices and selection of excellent leaders. Chandra may not care much for either. The business is a family-run affair, controlled by Chandra, his son and his brother Laxmi Goel. The brothers don’t seem to get along and the business is poorly managed; dozens of top managers pass through the revolving door each year. Every few years, Chandra announces a reorganisation and re-branding. The most profitable of the channel companies is Sun TV Networks, which has 20 channels in four Indian languages and 43 FM radio stations targeted at the south Indian population globally. It also has two daily newspapers and four magazines. Sun has no long-term debt. Its consolidated revenue was up 28% in FY08 over the corresponding year-ago period while operating profit was up 26%. Unlike other channels, which spend heavily on their operations with a major chunk being generously doled out to employees, Sun controls its costs. Operational cost is an average 31% of revenue which helps it enjoy huge margins. Sun’s operating margin of 69% is among the highest in India. It earns a very high operational RoCE (42%). In the second quarter of FY08, it got into film production through its new division, Sun Pictures.

Even if genuine, this glorious picture conceals a huge risk. Sun’s business was not built on competitive advantage alone but also through strong political connections.Sun is controlled by the Maran brothers – Kalanidhi and Dayanidhi – who have been close to the ruling DMK. It has a lock on the television business in Chennai, mainly the cable business. But political connections can be fragile. The brothers got into a spat with M Karunanidhi, the chief minister of Tamil Nadu, who suspected them of working against his family’s interests. Dayanidhi had to give up his ministerial position at the Centre and Sun came under severe competitive threat from the new channels and cable business backed by Karunanidhi. The stock was hammered and has remained a pariah for almost two years. Since early December 2008, it has started gaining ground on the news that the Marans and Karunanidhi have patched up. Sun’s strengths are known – and factored into the price. What is unknown is the political risk in its business model. Political alignments in Tamil Nadu are highly unpredictable and politicians there are crude and vengeful. In other words, Sun’s spectacular profitability is because of a moat business but that moat can run dry anytime. Only the most adept traders should be tempted to dabble in this stock.

In short, television channels are being operated in the interest of promoters and employees and not for shareholders, the most obvious manifestation of which are high expenses and generous stock options on the one hand and low return on capital on the other. If a company’s ability to utilise capital efficiently reveals managerial discipline, the worst among them are TV channels, except possibly Zee News and Sun TV. However, being glamour stocks, their prices have not fallen to anywhere near their fair values. NDTV and ibn18 are the most expensive of the lot, given their poor prospects. Good luck, if you have these in your portfolio.Source:Moneylife

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Arun.K.Mukherjee

A 26 year old bong lad from the outskirts of kolkata who loves stock markets more than his gfs or anything.Here in the stocks world since when i was 14,started investing in markets with 1000rs which compounded and has turned "a decent respectable portfolio" now.Learning everyday still a novice who intent to put news and stuff which were out of reach to simple retail investors.